International Economic Conditions

The Board's discussion about economic conditions opened with the observation
that economic growth in Australia's major trading partners appeared to
have been around average in the June quarter. Consumption growth had been little
changed for most trading partners in recent months, although it was perhaps
a bit stronger in the United States and somewhat weaker in China. The level
of consumption in Japan remained well below that seen prior to the increase
in the consumption tax in 2014. Core inflation rates had been stable in year-ended
terms over recent months and remained below the targets of most central banks.
Members also observed that trade volumes, particularly within the Asian region,
appeared to have fallen recently. Consistent with this observation, growth
in industrial production across a number of east Asian economies had slowed
a little.

In China, there had been little change in the monthly indicators of economic activity,
although conditions had been a bit more positive in some sectors than early
in 2015. The Chinese property market had improved somewhat; residential property
prices overall had risen for the first time in a year and floor space sold
had increased in the past few months. Members reflected that the recent easing
in monetary conditions would provide additional support to the property market
and growth more broadly, although it could be some time before a significant
pick-up in construction activity began. Recent efforts by central government
authorities to increase infrastructure investment further and reform local
government financing arrangements were also expected to support investment.

Commodity prices overall had fallen since the previous meeting, driven by iron ore
and oil prices. Growth in crude steel production had been modest and steel
prices had fallen noticeably over the past month. Iron ore production in China
had continued to decline. Shipments of iron ore from Australia and Brazil appeared
to have increased in June, which contributed to lower iron ore prices over
the past month.

Following quite strong output growth in Japan in the March quarter, more timely indicators
pointed to modest growth in the June quarter. Labour market conditions had
continued to improve, resulting in the unemployment rate falling further and
the ratio of jobs to applicants continuing to rise. Wage growth and financial
market measures of inflation expectations were higher than a year earlier and
were expected to feed into higher core inflation over time. Members considered
the importance for Japan of policy reforms designed to address some longer-term
structural challenges, such as the ageing of the population.

In the United States, recent data pointed to moderate growth in economic activity
in the June quarter following weakness in the March quarter. The labour market
had strengthened further, with growth in non-farm payrolls employment rebounding
in April and May and the unemployment rate falling. While there had been some
increase in measures of wage growth, core measures of inflation remained below
the Federal Reserve's inflation target.

In the euro area, the available indicators pointed to modest economic growth and
above-average sentiment in the June quarter, continuing the recent trend of
improved conditions in the euro area as a whole. Members noted that exports
had made a significant contribution to the pick-up in growth in the region
but investment was still well below the levels seen prior to the global financial
crisis. The unemployment rate had continued to fall modestly since its peak
two years earlier, but varied sharply across the euro area; the unemployment
rate was highest in Greece, where output was more than 25 per cent below
its level prior to the financial crisis.

Domestic Economic Conditions

Members noted that output had increased by 0.9 per cent in the March quarter
and by 2.3 per cent over the year. Resource exports had made a significant
contribution to growth, reflecting better-than-usual weather conditions in
the quarter. Dwelling investment had remained strong and while consumption
growth had picked up over the past year or so, it had remained below average.
Business investment had contracted in the quarter and there had been little
growth in public demand. More recent economic indicators suggested that domestic
demand had continued to grow at a below-average pace over recent months, but
that labour market conditions had continued to improve.

Members observed that consumption grew faster than household income over the year
to the March quarter. As a result, the saving ratio had declined further, although
it remained well above the level it had been over much of the past 25 years.
Year-ended growth in retail sales had been little changed over recent months
and liaison suggested that this was likely to have continued into June. Retail
sales growth had been relatively strong in New South Wales and Victoria but
weaker in Queensland and Western Australia, in line with observed differences
in economic conditions across the country. At the same time, surveys indicated
that consumers had viewed their financial situation as being above average
over the past year, notwithstanding the relatively weak growth in labour incomes.
Members observed that this was likely to reflect the very low level of interest
rates and strong growth in net household wealth.

Dwelling investment increased by 9 per cent over the year to the March quarter. An
increase in the construction of new dwellings accounted for most of this growth,
but the alterations and additions component had also contributed more recently,
recording the first increase in a year in the March quarter. Forward-looking
indicators pointed to further strong growth in dwelling investment in the period
ahead. Members noted that there had been ongoing divergence in conditions in
established housing markets across the country, as well as between houses and
apartments. Housing prices had continued to rise rapidly in Sydney and to a
lesser extent in Melbourne. Elsewhere, there had been little change in housing
prices over the past six months or so. Prices of apartments had been growing
less rapidly than those of houses, which members considered to be consistent
with the relatively strong growth in the supply of higher-density housing in
many capital cities.

Growth in housing credit overall had been stable over recent months at around 7 per
cent on an annualised basis, while growth in lending to investors had been
steady at a bit above 10 per cent. Members observed that the household
debt-to-income ratio, calculated by netting funds held in mortgage offset accounts
from total household debt to the financial sector, had increased over the year
to March but had not exceeded previous peaks. Members discussed the fact that
high housing prices had different implications for existing home owners, who
benefited from increased wealth, and potential new home owners, who were finding
it more difficult to finance a home purchase.

Investment in both the mining and non-mining sectors appeared to have fallen in the
March quarter, although the split between the two components remained subject
to some uncertainty. Profits for non-mining firms had increased by 6 per
cent over the past year. More recent survey measures of business conditions,
confidence and capacity utilisation had picked up to be around, or even above,
their long-run averages. In contrast, private non-residential building approvals
had remained weak.

The monthly trade data suggested that resource exports, including iron ore and coal,
had declined in the June quarter. Coal exports had been affected by the severe
storms in the Hunter region of New South Wales in late April. Members noted
that there had been further signs of growth in service exports, in part a response
to the depreciation of the exchange rate. Over the past year, net service exports
had made a similar contribution to output growth as exports of iron ore, even
though total import volumes had increased in the March quarter.

Labour force data indicated further signs of improvement in May. Employment growth
had picked up over the year to exceed the rate of population growth. As a result,
the unemployment rate had been relatively stable since the latter part of 2014
and had fallen slightly in May to 6 per cent. Members observed that employment
growth had been strongest in household services and that employment and vacancies
had been growing for business services but had remained little changed in the
goods sector. As with other state-based indicators, employment growth and job
vacancies had been strongest in New South Wales and Victoria. Forward-looking
labour market indicators had been somewhat mixed over recent months. The ABS
measure of firms' job vacancies overall suggested that demand for labour
could be sufficient to maintain a stable or even falling unemployment rate
in the near term, while other forward-looking indicators suggested only modest
growth in employment in coming months.

Members noted that the latest estimates indicated that the population had increased
by 1.4 per cent over the year to the December quarter, down from a peak
rate of growth of 1.8 per cent over 2012. The slower growth was primarily
accounted for by a decline in net immigration, which was particularly pronounced
in Western Australia and Queensland, consistent with weaker economic conditions
in those states. Members observed that the lower-than-expected growth in the
population helped to reconcile the below-average growth in output over the
past year with a broadly steady unemployment rate.

Despite recent improvements in labour market indicators, members reflected that there
was still evidence of spare capacity in the labour market. Consistent with
this, the latest national accounts data indicated that non-farm average earnings
per hour had recorded the lowest year-ended outcomes since the early 1990s
and that unit labour costs had been little changed for around four years.

Financial Markets

International financial markets were mainly focused on developments in Greece and
the fall in Chinese equity markets over the past month.

Members were briefed on recent developments in Greece. The ‘no’ vote
in the referendum on the creditors' latest proposals raised several issues,
first among which was how the Greek authorities could reopen the banks. A critical
vulnerability in the near term was related to whether the European Central
Bank would provide additional emergency liquidity assistance. A second issue
was how Greece would be able to service its external debt and a third was the
challenges faced by the Greek authorities in improving the competitive position
of the economy. Although these issues were of great concern to the Greek populace,
the direct economic implications for the global economy and Australia were
assessed by members to be relatively limited. They noted that the reaction
of financial markets to these developments had been fairly muted. This was
consistent with the economic and financial exposures to Greece – apart
from the official sector's financial exposure – being quite low.

Members noted that spreads to 10-year German Bunds on comparable bonds issued by
Italy, Spain and Portugal had not risen much, with the limited contagion from
developments in Greece likely to have reflected a general view of markets that
previous adjustment policies in those countries had been relatively successful.

Members then turned their discussion to developments in bond markets more generally.
Yields on longer-maturity German Bunds and US Treasuries had risen sharply
over the first half of June, with German 10-year yields reaching
1 per cent, compared with a historic low of 8
basis points in mid April. German yields declined somewhat following the announcement
of the Greek referendum. Longer-term sovereign yields of most other developed
countries, including Australia, tended to move in line with US Treasuries.

Expectations about the timing of the US Federal Reserve's first increase in the
federal funds rate were little changed over the past month. Market pricing
continued to suggest that the first increase would occur around the end of
2015. Although commentary by Federal Reserve officials suggested that it could
be a little sooner than that, they continued to emphasise that the exact timing
of the first increase would be less important than the pace of subsequent increases,
which were expected to be gradual.

The People's Bank of China (PBC) eased monetary policy further in June by cutting
benchmark deposit and lending rates by 25 basis points, citing low inflation
and a consequent increase in real interest rates. In addition, the PBC announced
cuts to the reserve requirement ratio for selected financial institutions.
The Chinese authorities had also announced a proposal to allow banks more flexibility
in their choice of funding mix and asset allocation, which could lead to an
increase in the supply of credit over time.

The Reserve Bank of New Zealand lowered its policy rate by 25 basis points, to 3.25
per cent, citing the decline in New Zealand's terms of trade and the disinflationary
effect of stronger-than-expected labour force growth.

Global equity markets fell by 3 per cent over the course of June, with broad-based
falls and price movements generally tending to reflect fluctuations in sentiment
about Greece. The Chinese equity market also fell sharply in June, partly in
response to what was only a modest tightening of restrictions on margin lending.
Mainland share prices were still well above their levels of a year earlier
but the sharpness of the recent fall prompted the Chinese authorities to announce
a number of measures, including an indefinite suspension of initial public
offerings, an equity stabilisation fund and a funding facility for brokers.
The Australian equity market underperformed several other advanced economy
markets in June, mainly reflecting falls in resources and consumer sector share
prices.

Global foreign exchange markets were relatively subdued in June. The euro recorded
only a modest and short-lived fall when markets opened after the announcement
of the Greek referendum result. The Australian dollar was 3 per cent
lower against the US dollar and on a trade-weighted basis.

Corporate bond issuance in Australia had been strong over the course of 2015 to date,
particularly by resource companies, although much of the increase reflected
refinancing.

Pricing of Australian money market instruments suggested that the cash rate target
was expected to remain unchanged at the present meeting.

Considerations for Monetary Policy

Members noted that global economic conditions remained consistent with growth in
Australia's major trading partners being around average over the period
ahead. Global financial conditions were very accommodative and would remain
so even in the event that the Federal Reserve started to raise its policy interest
rate later in the year. Recent data suggested that conditions in Chinese property
markets had improved and the authorities had acted to support activity by easing
a range of policies further. Members noted that the recent volatility in Chinese
equity markets and potential spillovers from developments in Greece would require
close monitoring.

Domestically, the key forces shaping the economy over the past year were much as
they had been for some time. Very low interest rates were working to support
strong growth in dwelling investment and, together with strong housing prices,
had supported consumption growth. Resource exports had made a substantial contribution
to growth and mining investment had declined significantly, while public demand
had been flat over the past year. Although output growth in the March quarter
had been stronger than expected, growth over the year remained below average
and early indications were that the strength in the March quarter had not carried
through to the June quarter. Non-mining business investment had been subdued
and surveys of businesses' investment intentions suggested that it would
remain so over the coming year. Nevertheless, non-mining business profits had
increased over the past year and surveys suggested that business conditions
had generally improved over recent months to be a bit above average.

Conditions in the housing market had been little changed in the most recent months,
with notable strength in Sydney. Housing credit growth had been steady and
remained relatively strong for investors in housing, although it had not accelerated.
Any effects of regulators' greater scrutiny of investor lending were probably
not yet evident in the data.

Recent data indicated that employment had grown more rapidly than the population
and the unemployment rate had been relatively stable since the latter part
of the previous year. The easing in population growth over the past year helped
to reconcile below-average growth in output with the relatively steady unemployment
rate. Nevertheless, spare capacity remained, as evidenced by the level of the
unemployment rate, historically low wage growth and unit labour costs that
had been stable for a number of years. On this basis, members assessed that
inflationary pressures were well contained and likely to remain so in the period
ahead.

Commodity prices had fallen further and the Australian dollar had depreciated over
the past month. Although the exchange rate against the US dollar was close
to levels last seen in 2009, the decline in the Australian dollar had been
more modest in terms of a basket of currencies. Members noted that the exchange
rate had thus far offered less assistance than would normally be expected in
achieving balanced growth in the economy and that further depreciation seemed
both likely and necessary.

In light of current and prospective economic circumstances and financial conditions,
the Board judged that leaving the cash rate unchanged was appropriate. Information
to be received over the period ahead on economic and financial conditions would
continue to inform the Board's assessment of the outlook and hence whether
the current stance of policy remained appropriate to foster sustainable growth
and inflation consistent with the target.